Why Q3’s GDP Print Doesn’t Mean Recession Avoidance
The only saving grace of the GDP report was its headline +2.6%. As it turns out, Net Exports added 2.8 percentage points, and for the wrong reasons. Excluding Net Exports, the domestic economy’s GDP growth was -0.2%. The Recession continues. While the country still has a large negative balance of trade, it is the change that plays into the growth of GDP. Because of the dollar’s strength, the dollar value of exports rose. Yet, despite that strong buying power, imports fell. Lower imports tells us something about the U.S. consumer.
Final sales to private domestic purchasers were flat (less than 0.1% at an annual rate compared to +0.5% in Q2, +2.1% in Q1, and +2.6% in Q4/21. The chart at the top tells the real story about a weakening U.S. consumer (the black bars – note the lack of such on the right-hand side). Services held up the best with vacations rising +6.3% (appears to be due to pent-up demand after two summers of Covid related issues). On the other hand, the purchase of goods were weak with durable goods falling at a -0.8% annual rate (-2.8% AR AR in Q2) and non-durables down -1.4% (AR) (down three quarters in a row).
Lest you succumb to the narrative that the positive GDP print means a Recession has been avoided, you should know that it isn’t uncommon to have a positive real GDP quarter within a recession. In 2008’s Great Recession, the following was the sequence of the quarterly GDP prints: Q1’08: -1.6%; Q2’08: +2.3%; Q3’08: -2.1%; Q4: ’08: -8.7%. In the dot.com bubble bust: Q1’01: -1.3%; Q2’01: +2.5%; Q3’01: -1.6%. We find a similar pattern in the recessions of the ‘70s and ‘80s. Given the rest of the incoming data (see below), it is quite clear to us that this Recession is continuing.
Equity Market Index Disparity
On top of the news (leaked by the Fed) on Friday October 21st that they were thinking about “stepping down” rate hikes, when the Commerce Department reported that Q3 GDP grew at a +2.6% annual rate (Thursday, October 27th), the immediate reaction of the sell side commentators was that “a recession has been avoided,” or “there will be a soft-landing.” The Dow Jones (DJIA), which had risen +750 points the day of the Fed leak, and continued its rise on Monday (+417) and Tuesday (+337), went on a rampage again on Thursday (+194) and Friday (+829). Total points added since the last down day (Thursday, October 20th) were +2,529, an +8.3% up-move in just six trading days. While the Russell 2000 index was up a similar +8.4% over that time span, the S&P 500 (+6.4%) and Nasdaq (+4.6%) indexes weren’t as robust.
It is apparent from the table (right hand column) that the DJIA and Russell significantly outperformed the Nasdaq and S&P 500 since hitting their cycle lows. The reason is the weight of technology stocks. The DJIA has a technology weight of less than 20%. In contrast, the Nasdaq is much more technology oriented (49%). (The S&P 500’s tech weight is 27%.) Last week, despite the general market rally, several of Nasdaq’s and S&P 500’s highly weighted tech holdings disappointed, including Alphabet, Meta, and Microsoft MSFT . Amazon AMZN , another highly weighted Nasdaq stock, also disappointed. One must wonder how bright the immediate future can look when the country’s major growth sector isn’t growing!
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The media generally reports the market results using the DJIA, but the vast majority of investor portfolios hold a significant portion of tech stocks. As a result, the DJIA’s recent performance isn’t typical for investor portfolios.
Mortgage purchase applications continue to plumet, down -2.3% the week of October 21st (and down -42% Y/Y). This isn’t a wonder as 30-year fixed mortgage rates (7.16%) are the highest since 2001. And refi applications, often used for big ticket items have just about dried up. (Not surprising as current homeowners with 3% mortgages aren’t voluntarily going to move to 7% rates.)
New home sales were down -10.9% M/M in September, -14% YTD, and -17.6% Y/Y. If speculative sales are removed (i.e., sales to intermediaries), sales to end users (i.e., owner occupiers) were down -19.4% M/M. For the homebuilders, September’s sales of completed units fell -30.5% from July’s already weak levels. In the existing home market, the news is no better. Pending home sales (newly signed contracts) were off -10% M/M in September and down -31% Y/Y.
If we look at the recent GDP release, we find that in Q3 Residential Investment fell at a -26.4% annual rate, with Non-Residential Construction not far behind, falling in Q3 at a -15.4% rate and now down six quarters in a row to the lowest level in 11 years.
In Canada, home prices have already deflated -17% from their February peak with price falls now accelerating. Can home prices in the U.S. be far behind? The Case-Shiller Home Price Index fell -1.3% M/M in August (latest data) on top of July’s -0.7%. August was the steepest one month decline since March ’09 (remember that housing market?). The Federal Housing Finance Agency’s (FHFA) home price index fell -0.7% in August (also the latest data) and its three-month annual rate of change is -4.8%. October is at an end. Surely these price trends have accelerated! Since housing is the most interest sensitive sector, we can expect similar reactions in other major sectors as the impact of rising interest rates takes its toll.
- The NY Fed’s weekly economic index continues to fall – not a good sign for economic growth.
- The Richmond Fed’s Manufacturing Index came in at -10 for October vs. 0 for September. Shipments were -3 vs. +4 and new orders -22 vs -11 (not a pretty pictured!). The inflation metrics were promising: Backlogs -28 vs. -25 and Supplier Delivery Delays -15 vs. -11. The latter was the lowest since March ’09. Hiring, capex, and wage plans were at their lowest levels since 2020, and the six month “expectations” index weakened.
- Customer traffic at fast-food outlets fell -6.9% in August (latest data), down four months in a row. This is a reliable recession indicator.
- In Q3, gasoline usage (volume) was down -3.7% Y/Y, another indicator of consumer pain.
- Supply chain issues have been instrumental in the current inflation and the poster-child of supply chain problems was the back-up at California ports. Remember the pictures of ships at anchor off Los Angeles? The chart shows that early in the year there were more than 100 ships at anchor waiting to be unloaded. The right-hand side shows that ships in queue are now at a record low. That says something about both inflation and Recession!
- The GDP price deflator was +4.1% (annual rate) in Q3, lower than the consensus call of +5.3%, but still likely too high for this Fed. In Q2, this was +9.0%! Core PCE (Personal Consumption Expenditures Index), a favorite of the Fed, rose +4.5% in Q3 vs. 4.7% in Q2 and 5.6% in Q1.
- · In the rest of the world, economic conditions also continue to worsen. The chart shows the PMIs for the U.S., Europe, and Japan. Note that Japan is the only economy showing any sign of expansion, likely because the Bank of Japan (BoJ) has not embarked on a rate hiking cycle. The cost, however, has been high as the BoJ has had to use a significant portion of its reserves to keep the Yen from rising above 150/dollar.
- Note also that China’s real estate sector is in shambles (chart). The fact that economic data releases were delayed until after the meeting of the 20th National Congress (that gave Xi Jinping an unprecedented third 5-year term) is, in itself, telling of economic weakness there. This can’t be good for world trade.
Despite the positive GDP print for Q3, a deeper look reveals that the Recession has begun and that critical parts of the economy continue to weaken. The Fed meets on November 1-2. The GDP and PCE price deflators are likely still too high to stop a 75 basis point rate hike. Critical will be Friday’s (November 4) jobs report. We’ve already seen weakening trends in the underlying employment data, like a large rise in part-time jobs and growth in those holding more than one job, a significant return to the job market of those in the 55+ age cohort, and a rise in layoff announcements.
In our view, given what we see in the economic tea leaves, the Fed’s tightening cycle will end sooner than the markets currently believe for two reasons: 1) inflation will fall faster than the Fed (and markets) currently believe, and 2) the Recession will deepen rapidly and be around longer than currently anticipated.
(Joshua Barone contributed to this blog)